Weakening of Rupee – Causes & Consequences – Explained Pointwise

The Indian rupee has continuously been weakening against US dollar in recent past. The rupee has lost almost 6% of its value against dollar over the past year. There are many factors which are responsible for weakening of the Indian rupee even when the currencies of other emerging market economies are strengthening against dollar.

What are the factors responsible for weakening of the Rupee against Dollar?

1. Domestic Factors:
   1. Widening Current Account Deficit (CAD): The CAD is expected to rise significantly in the Fiscal Year 2025-26, with forecasts indicating a rise to ~1.7% of GDP. This widening of the deficit is mainly driven by a large merchandise trade deficit.
   2. Sustained FII (Foreign Institutional Investors) Outflows: 2025 has been characterised by a sustained net selling trend by FIIs in both Indian equity & debt markets. This capital flight reduces the supply of foreign currency & directly pressures the rupee.
   3. Inflation & Growth Headwinds: Even though, the long-term growth outlook remains strong, but, the slower near-term GDP growth & very low inflation level have acted as negative economic indicators, dampening investor confidence in Rupee’s short term stability.
2. External & Global Factors:
   1. India-USA Trade Tensions & Tariffs: USA is India’s one of the top trading partners. However, the imposition of 50% tariff on Indian goods by the Trump administration has severely impacted the export competitiveness of Indian goods & has increased the market risk perception – making Indian rupee the worst performing currency in Asia for the year.
   2. Strengthening of USA Dollar: Despite the US Fed Reserve beginning its rate-cut cycle, the US Dollar has maintained persistent strength, reflecting its status as global reserve currency & a safe haven asset during a period of geopolitical uncertainty. Strengthening of US dollar against major currencies puts pressure on INR.
   3. High Crude Oil Demand & Import Bill: India imports almost 80-85% of its crude oil. The rise in the crude oil prices & that of the important commodities imported by India like gold – lead to widening of India’s trade deficit & weakening of INR.
3. Monetary Policy Factors:
   1. Unfavourable Interest Rate Differentials: Even though the US Fed Reserve has begun its rate-cut cycle at a modest rate (e.g. 25 basis point cut in the late 2025), the cumulative interest rate differential remains attractive for the US Dollar relative to Rupee’s real yield – driving the capital away from India.
   2. RBI’s Stance: The RBI has chosen a Neutral Policy Stance & kept the repo rate unchanged for most part of the year 2025 – prioritizing domestic liquidity management & growth oven an aggressive defense of the Rupee.

What are consequences of weakening of the Rupee?

1. Impact on Consumers:
   1. Inflationary Pressure: As the INR weakens, the Oil Marketing Cos. have to pay more Rupees for the same barrel of oil. This increased cost is eventually passed on to the consumers through higher prices for petrol, diesel, and natural gas. This high fuel cost then triggers a cascading effect – contributing to broader consumer price inflation.
   2. Cost of Goods: The price of other key imports, such as electronics, gold, industrial chemicals, and fertilisers, also rise – intensifying the inflationary pressure & eroding the purchasing power & savings of the average household.
   3. Foreign Travel & Education: Foreign travel & education will become significantly expensive.
2. Impact on Trade (Imports/Exports):
   

   The WINNERS

   Increased Competitiveness: A weaker rupee makes the Indian goods & services cheaper for foreign buyers who pay in Dollars. This can boost the competitiveness of Indian exports in global market. High Profitability for Exporters: Indian exporters, particularly the IT Service Sector, benefit significantly. Weakening of the INR directly boosts their profit margin & revenue growth. Boost to Domestic Investment: Rise in export revenue can lead to increased domestic investment as exporters look to expand capacity to meet the higher demand.

   The LOSERS

   Higher Import Bill: Weakening of the Rupee against Dollar puts upward pressure on the net import bill. Wider Trade Deficit: The cost of essential imports outweighs the revenue gain from exports. A significant rise in import bill can lead to a widening of the Trade deficit.

3. Impact on Corporates (External Debt):
   1. Increase in Debt Servicing Cost: The Indian Corporates who have taken ECBs denominated in USD & have not fully hedged their exposure, face a major risk. A weaker rupee means that a company has to pay more amount of INR for the USD-denominated debt.
   2. Divergent Fortunes: The corporate sector witnesses a divergence – while the export-oriented cos. see higher profits, the import-dependent cos. & highly indebted cos. face significant financial strain.
4. Macroeconomic Impact:
   1. Forex Reserves Drawdown: The RBI often intervenes (spot intervention) in the forex market to prevent excessive depreciation of the Rupee. The RBI sells USD to absorb the excessive Rupee liquidity. However, it leads to reduction in the national reserve buffer.
   2. Capital Flight: Withdrawal of funds by FIIs is one the causes for the weakening of the INR. If the Rupee continues to weaken, it could signal greater macroeconomic instability which may increase the rate of capital flight from India – creating a self-perpetuating cycle of depreciation.

What should be the way forward?

1. Strengthen Macro-fundamentals:
   • Contain fiscal and current account deficits through better tax mobilisation, rationalised subsidies, and export diversification so external financing needs remain credible.
   • Keep inflation durably low and stable via prudent monetary-fiscal coordination, which reduces the long‑run tendency of the rupee to lose purchasing power versus the dollar.
2. Manage External Vulnerability:
   • Reduce import dependence in oil, gas, electronics, fertilisers and defence through domestic capacity, renewables, and energy efficiency, lowering structural dollar demand.
   • Maintain adequate forex reserves and flexible exchange rates so the RBI can smooth volatility without defending unsustainable levels, reassuring markets about India’s shock‑absorbing capacity.
3. Upgrade Export Competitiveness: Upgrade export competitiveness with reforms in logistics, trade facilitation, skilling, and industrial policy, focusing on high‑value manufacturing and services instead of low‑margin commodities.
4. Attract Capital Inflows: Attract stable FDI and long‑term portfolio flows by improving contract enforcement, regulatory predictability, and financial‑sector depth, reducing reliance on short‑term “hot money”.
5. Safeguard Vulnerable Sectors & Households:
   • Encourage firms with foreign‑currency liabilities to prudently hedge and improve disclosure, limiting balance‑sheet stress from sharp currency moves.
   • Use targeted support (e.g., fuel tax calibration, transport and fertilizer support, food security buffers) to protect poorer households from imported‑inflation spikes without large, open‑ended subsidies.
6. Long-term Solution: Continue structural reforms (land, labour, financial inclusion, digital public infrastructure) that raise productivity and long‑term growth, making India more attractive to capital and easing pressure on the rupee over time.